A wealth of opportunities: Cayman investment funds and Latin American HNI’s

With a record number of billionaires hailing from Latin America this year1, predictions are that the region will only get wealthier and Brazil is leading the way2. As a result of higher commodity prices and a stronger currency, the number of billionaires in Brazil increased by 60 per cent between 2009 and 2010. Brazil is now estimated to have the 10th largest population of high net worth individuals (HNIs) in the world3. With increased wealth, Latin American HNIs are motivated to search for optimal vehicles and domiciles to diversify, protect and enhance their holdings.

Traditionally, Latin American HNIs have favoured using offshore holding companies to facilitate investments overseas and many have invested in offshore funds. However, following the global economic crisis, Latin American HNIs have demanded greater transparency and control over their investments and as a result, requests to establish family funds have been on the rise. By establishing family funds, Latin American HNIs may consolidate their investments into a formal structure which is flexible, transparent and allows for control over strategy, operation and risk. Family funds may also be tailored to suit specific needs. For example, funds structured as segregated portfolio companies, allow individual family members to have separate segregated portfolios, managers and custodians within a single vehicle.

Why Cayman funds are appealing

Latin American HNIs find Cayman an attractive domicile for family funds for the same reasons Cayman is regarded as the leading investment funds jurisdiction. Cayman is a sophisticated, stable and tax neutral jurisdiction, famous for responding rapidly to market requirements, as well as economic and regulatory developments. Cayman offers quality service providers, is well regulated and boasts a Commercial Court served by specialist judges who are qualified to resolve complex commercial disputes. Additionally, Cayman’s common law legal system provides comfort, certainty and protection for investors.

Aside from these well known features of Cayman as a domicile, Latin American HNIs find Cayman funds appealing for other reasons, mostly relating to local conditions in Latin America.

Cayman’s welcoming environment

Business goes where it is invited and Cayman is welcoming Latin American HNIs to its shores. In Cayman, there is clear recognition of the importance of Latin America to the world economy and of the significant opportunities for economic cooperation that exist. In 2008, Cayman industry leaders visited Brazil to increase awareness of Cayman offshore services. Since then, the relationship between Cayman and the region has deepened, with the Cayman Islands Monetary Authority concluding formal arrangements with the Brazilian Securities and Exchange Commission (CVM) and the Mexican Banking and Securities Commission.

Cayman’s service providers have adapted to cater to Latin American clients. Many employ professionals who are fluent Portuguese and Spanish speakers, have cultural experience of Latin America and are able to provide the personal service which the region’s HNIs require.

Though large Brazilian institutions have had a presence in Cayman for some time (Banco do Brasil, Bradesco, Itaú), the recent acquisition of a Cayman bank by Brazilian family conglomerate Cohab/Aboulafia demonstrates that efforts to increase economic cooperation have been successful. Cohab gave as reasons for its attraction to Cayman, its political stability and the quality of its regulatory regime and service providers.

Availability of registered structures

Latin American HNIs appreciate investment funds which may be registered by a recognised regulatory body. Cayman funds can be registered with CIMA and though family funds often qualify for exemption from registration under applicable law4, many Latin American HNIs opt for registration5 as this gives substance to the structures in dealings with counterparties and domestic authorities. In Brazil for example, the bona fides of unregistered funds is sometimes questioned by the tax authority when assessing payments received by Brazilian investors.

Tax mitigation

HNIs find Cayman funds appealing from a tax perspective, when compared to offshore holding companies, either for overseas investment or for re-investment in Brazil. Investment through a Cayman fund may result in a reduction in the amount of Brazilian tax paid on earnings from these investments. Redemptions of equity interests in a Cayman fund are subject to 15 per cent tax in Brazil on the capital gain. Payment of tax is deferred until redemption. By contrast, where investments are made through overseas holding companies, dividend payments are subject to tax in Brazil at the higher rate of 27.5 per cent and any gains on realisation of the investment are also subject to 15 per cent capital gains tax.

Protection of assets

HNIs in many Latin American countries fear state powers which may be exercised over private property. Such powers range from the forced nationalisation of private property in Venezuela to the authority of the Central Bank in Brazil to freeze assets of individuals who are directors of, or connected to, insolvent companies. One way in which investors may guard against such appropriation is by placing assets in a Cayman fund.

Currency protection

Investments made through a Cayman fund may serve to shelter private wealth from local market and currency fluctuations. These fluctuations are common and frequently occur around the time of elections. Notably, on 6 June 2011, the Peruvian stock exchange suffered a record fall following the presidential run-off election.

Succession planning

Cayman funds are also an attractive option for succession planning. Forced heirship rules, applicable in the South American Latin countries, but not Mexico or Central America, limit discretion to dispose of assets on death. These rules allocate a proportion of the deceased’s estate to certain heirs in preference to others. In Cayman, there is testamentary freedom and investments in Cayman funds, which are disposed of by a valid Cayman will, may be preserved from the effects of forced heirship.

Comparison of Cayman and Brazilian investment funds

An examination of some differences in the features of Cayman funds and Brazilian domestic funds will further highlight the attractiveness of Cayman funds for Latin American HNIs.

(i)Permitted activities

Investment funds in Brazil are highly regulated and consequently, Brazilian funds may lack the flexibility that HNIs desire. Fund strategy, asset type and diversity are limited by the category of fund established. There are specific rules attaching to each category and only certain funds may invest overseas. Additionally, with the exception of private equity funds, Brazilian funds are not permitted to take loans. Cayman funds have far more flexibility. There are no legal restrictions on the asset type, asset concentration, strategy or overseas jurisdictions in which a fund may invest. There are also no legal restrictions on borrowing.

(ii)Structure

Brazilian domiciled investment funds take the form of a condominium with assets jointly owned by investors. Investors are jointly liable for the liabilities of the fund and such liability is unlimited. An investment in a Cayman fund offers more protection in this regard. Cayman funds may be structured as companies (exempted, segregated portfolio or exempted limited duration), partnerships or trusts. Companies have separate legal personality and hold assets separately from their investors. Assets of exempted limited partnerships and unit trusts are held separately from investors by the general partner and trustee respectively. In addition, investors in Cayman funds established as exempted limited liability companies and exempted limited partnerships enjoy limited liability.

(iii)Confidentiality

With numerous instances of kidnapping and theft in Brazil, for HNIs, it is important that details of their personal wealth remain private. However, domestic products may not provide the desired level of privacy. Brazilian funds must report their positions to the CVM and these are publicly accessible. Other details such as the names of operators are also published by the CVM and enquiry may often reveal to whom fund investments are attributable. Investment in Cayman funds provides greater comfort in this regard. Information reported to CIMA by registered funds (such as names of directors) is not made public and financial reporting is limited to annual audited financial statements which are also kept confidential.

(iv)Tax rate on profits

Generally6, an investment in a Brazilian fund, where the majority of assets held are not listed securities, will result in withholding tax on the capital gain made by the investor which is collected:

at the end of May and November each year at the rate of 15 per cent (or 20 per cent for short term investments) over the life of the investment under the “come-quotas”/”share-eating” regime; and

on redemption, at decreasing rates from 22.5 per cent to 15 per cent, depending on the maturity period.

By contrast, there are no direct taxes in Cayman. Even though Brazilians are taxed on their worldwide income, where correctly structured, a Brazilian resident would only be liable for Brazilian tax on capital gains made in a Cayman fund at the rate of 15 per cent.

Latin American HNIs have been drawn to establish Cayman funds by Cayman’s welcoming environment, sound regulation and quality infrastructure. The robust growth experienced in Latin America and specific local conditions have also opened doors for Latin American HNIs to benefit from using Cayman funds. As Latin America’s rise continues, Cayman is well placed to facilitate the region’s journey, by providing innovative fund products tailored to suit the needs of HNIs. It is anticipated that there will be increased use of Cayman funds by Latin American HNIs as complementary and alternative investment options.

Endnotes

Forbes Magazine Rich List 2011.

Financial Times, “BRICs becoming billionaire factory”, 9 March 2011.

2010 Capgemnini World Wealth Report

Mutual Funds Law (2009 Revision) of the Cayman Islands (the “Mutual Funds Law”)

Registration is only available to investment funds which fall within the definition of mutual fund under the Mutual Funds Law.

A detailed analysis of the tax regime in Brazil for fund investors is beyond the scope of this article.

Janet specialises in Corporate Law with focus on investment funds. She has considerable experience advising investment managers, institutional and private investors, and service providers on the establishment, re-structuring and on-going operation of Cayman Islands alternative investment funds.

Graeme’s practice is concentrated on corporate law with a focus on investment funds and Latin America. Graeme previously practised at private equity specialist, Dickson Minto WS and at Herbert Smith LLP in London, advising on international transactions. Graeme is fluent in Portuguese, Spanish and French.